Housing Affordability – The Shift To Reality

The UK Financial Times
article Painful Adjustments Ahead for Banking System by
John Plender should be read closely, to gain a sense of the
magnitude of the unwinding currently underway within the
global financial system. And it is all “happening”
rather quickly.

Dr Alan Greenspan was the architect
of the financial liquidity bubble – and before too long
will be widely recognised as such. History will likely be
very harsh on him. But the liquidity bubble was exacerbated
by poor urban regulatory performance as well - strangling
supply and creating further massive asset bubbles –
fuelling even greater excess liquidity. This did not happen
in the open urban markets of middle North America, as the
Annual Demographia Surveys clearly illustrate.

Much
of the so called “global boom” (in reality a bubble) we
have had since the late 1990’s – has been caused by
these two key factors.

What is important about this
UK Financial Times article, is that it explains how a
(perceived – not real) virtuous cycle can so quickly turn
in to a vicious one. The reality is that no one knows the
extent of the losses that will be incurred as this whole
unfortunate and indeed unnecessary urban inflation process
unwinds. After all “assets” (across the board) are only
worth what people are “willing” to pay for them – and
lending institutions are prepared to lend on them.

Plender explains it very well within the article when he
says –

“Equally to the point, the banks year-end
preoccupation with liquidity distracts attention from the
big difficulty for 2008, namely that everyone in the
financial system is capital – constrained.Also capital
constrained are households in those economies that have
suffered from explosive house prices, which is where the
linkage with the broader economy could all too easily
precipitate recession (my emphasis)”.

He goes on
to say………..

“Estimated system wide losses of
$300 billion plus are largely based on marking banks trading
books to market. The real cash losses and defaults are yet
to come (my emphasis). And the defaults will not be confined
to the residential mortgage markets, where teaser rates are
set to rise. In countries such as the UK, Ireland and Spain,
lending to commercial property has been soaring as a
percentage of the overall loan book. The initial yield on
the property is below the banks cost of funds, so defaults
at some point are inevitable.”

It could be said
that Southern California (with the help from other US
coastal markets) is “leading the way” as this article
Southern California home prices tumble in November | Reuters
illustrates – where it states that median house prices
have declined about 10% November year on year.

Then
the question needs to be asked – “If previously they
were lending on artificially inflating housing prices, where
household income was either of little or no consequence –
what do they lend on now - in an environment of declining
house prices?” it cant be “assets” any longer of
course – because they don’t know what these will be
worth going forward.

It simply has to be
“income” - as it should have been all along – had
there not been these massive “regulatory failures” at
both national and local level.

The urban inflation
we have seen in too many markets over these past few years
has been “unprecedented” To gauge the extent of the
inflation component – one would need to adjust current
pricing back to a reasonable Median Multiple of 2.7 (the
“swing multiple in normal open urban markets – where the
“floor multiple” is 2.5 and the “ceiling multiple”
is 3.0).

We know from the 2007 3rd Edition
Demographia International Housing Affordability Survey that
the median Median Multiple for the major urban markets of
the 6 countries surveyed were – Canada 3.2; USA 3.7; UK
5.5; Ire 5.7; NZ 6.0 and Australia 6.6. It is simply a
matter of multiplying the housing stock by the average (not
median) price to arrive at the current total inflated values
of individual markets – then adjusting them by how
elevated they are above the normal open market “swing”
Median Multiple of 2.7, to get some sort of grasp on the
quantum of “artificially inflated value”.

It is
not a pretty sight – and should have been “obvious” to
politicians, bankers, regulators, economists, property
professionals, urban planners and others ten and twenty
years ago.

It needs to be borne in mind too – that
as markets “adjust” – they do not simply move casually
and conveniently back to their “equilibrium value” (in
the residential sector to the open market swing Median
Multiple of 2.7) – but tend to “overshoot”. We do know
from the Harvard University Median Multiples Tables that
historically most US urban markets were between 2 to 3
time’s annual household earnings.

It is difficult
to accept the idea that somehow this adjustment can be
“gentle” as the criteria for debt financing moves rather
quickly from that based on “ever inflating values” to
the “tried and true” historical convention of lending
based on income – which had been at 2.5 to 3.0 times (and
slightly higher) gross annual household income and no more
than 80 - 90% of the “true worth” (not artificially
inflated pricing) of the property being secured. It seems
likely that “assets” through this adjustment phase will
be considered “secondary” to incomes. It is likely too
lenders will now be making hurried efforts to adjust lending
criteria within the urban markets they are lending in to –
to “affordable” levels (i.e. 2.7 Median Multiple).

Banks and other lending institutions are currently
learning the hard lesson of just how “disloyal” property
owners can be to inflated lending, when reality property
pricing emerges as a bubble unwinds.

Property
Appraisers / Valuers will need to adjust to this “renewed
reality” rather quickly as well.

Through the
“bubble phase” - lending at 4, 5, 6 times household
income was common – even to the extent of 11 times
household income in California ($US90,000 household income /
one million dollar debt) as explained by a Mark Hanson
within Herb Greenberg » Blog Archive » Straight Talk on
the Mortgage Mess from an Insider . This article with the
generally high quality 600 plus comments that follow by
practitioners (not economists / property appraisers and
valuers - with sadly too often – a “textbook”
understanding of markets) provides an excellent overview of
the irresponsible lending practices which blossomed through
the bubble phase.

I would like to say that it has
surprised me (but it hasn’t) – that Banks and other
lending institutions have not protected themselves, by
clearly differentiating between “true value” and
“inflated value” of urban markets – in pressing
Governments at all levels, to take the necessary regulatory
steps to ensure urban markets did not inflate.

Instead – they chose to act as “cheerleaders” (and
with others who should have known better) to this rampant
inflation – as they clearly saw it as a short term
opportunity to generate enhanced revenues, profits and
particularly bonuses. I cannot recall hearing the
“voice” of one senior Banking official – anywhere –
warning of the dangers of this artificially induced urban
inflation.

To add insult to injury – many Bank
economists branded these artificially inflated values as
“household wealth”. Hardly surprising when they were
“selling” artificial property inflation as growth –
something that can only be described as gross
misrepresentation and blatant professional negligence.

It is to be hoped that they are now examining closely
where the quantum of household debt sits in relation to the
quantum of inflated value and the true value of individual
urban markets. They may well find that the quantum of the
true market values in many markets is uncomfortably close to
the quantum of household debt within these markets.

On the issues of alleged “misrepresentation” and
“professional negligence” - it will be interesting to
see how this all plays out in the Courts around the world
going forward, A media statement by the attorneys and case
summary and class action complaint vs UBS and a number of
its senior officers, is already underway. It is impossible
to predict how the vast range and numbers of “aggrieved”
seek justice from the Courts and other forums. There will no
doubt be different approaches taken in different
jurisdictions.

How “protected” public officials
are in jurisdictions with the Westminster system – where
the civil service at all levels of government is expected to
act with impartiality – will be most interesting.

It would be fair to predict however – that we are
likely to see rapidly increasing pressures to restore
regulatory and commercial disciplines within our urban
markets.

It is the politician’s role to react to
these pressures and they are ultimately judged on how they
manage these events, as the recent election in Australia
clearly showed - and reported December 8, 2007 in the Sydney
Morning Herald Fear of losing homes drove Labor win by
Stuart Washington. The SMH requested Fitch Ratings to
research the swing to the new Australian Federal Labour
Government and found that those suffering “mortgage
stress” voted strongly against the former Howard
Government to elect Labour.

The new Australian
Government will know full well – that it must – with the
States and Local Government – focus on opening up
affordable new fringe land supply to urban markets – or
face the consequences at the next election. It would appear
the current New Zealand Labour Government has yet to learn
this lesson.

Mr Tim Gattrell, Australian Federal
Labour Party National Secretary noted that the swing to
Labour was not confined to one single group but that the
party had made significant inroads among home loan
borrowers. Mr Gattrell went on to say that “people with
mortgage repayments of between $Aust1400 and $Aust1600 a
month, just above the average repayment, stood out as one
group that moved solidly to Labour”.

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